Ed Balls offered the most contrite assessment yet from Gordon Brown's inner circle concerning Labour's role in the run-up to the recession, when he admitted yesterday that ministers had underestimated the risks from the City of London.

Amid an intense debate in ministerial circles about whether Brown should offer an apology, his closest cabinet ally declared that the government had not been tough enough in regulating the financial industry. "In retrospect we all underestimated the risks and we were nowhere near tough enough," Balls told Sky News. "We need to learn from that and do it better in the future."

The intervention by the schools secretary, who, as economic secretary to the Treasury and Brown's chief adviser as chancellor helped establish a new financial regulatory framework after Labour's victory in 1997, was timely. Only hours earlier the Bank of England embarked on one of its most momentous steps since the economy dipped into recession by cutting interest rates to a record low of 0.5% and began the process of pumping tens of billions of new money into the economy.

George Osborne, the shadow chancellor, will today make clear the Tories regard the launch of quantitative easing as a landmark. In a speech in Birmingham he will say: "Our economy is broken, and Gordon Brown's sticking plasters won't mend it."

With the economy entering such a grave period, Balls made clear yesterday he believes the time has come to acknowledge the government's responsibility. "It is important to look back at the history and see what happened," he told Sky. "You have got to say 'yes, regulation wasn't right.' "

Balls spoke amid conflicting signals from ministers. Alistair Darling and Lord Mandelson have each spoken this week of the need for the government to show "humility". But friends of the prime minister insist that he has no intention of apologising, on the grounds that the recession originated in the sub-prime crisis in the US.

Balls is a key figure in an assessment of whether Labour is in any way to blame for what he has admitted is the worst financial crisis in a century. As Brown's adviser when he was chancellor, Balls was intimately part of the critical decision to grant independence to the Bank of England days after the 1997 election.

The move led to two major changes: the chancellor relinquished to the bank his power to set interest rates, and a new regulatory framework was established. The bank was stripped of powers handed to the Financial Services Authority. The authority has been criticised subsequently for allegedly adopting a light touch approach, while in turn the authority blames ministers for allegedly demanding it should not adopt an aggressive stance in its work.

Balls insisted that the government had adopted a tougher, risk-based, system of regulation in 1997. "We wanted a risk- based regulation where we were tough where the risks were high. In retrospect we all underestimated the risks and we were nowhere near tough enough. Completely right. We need to learn from that and do it better in the future."

The schools secretary then turned the tables on the Tories and the City for demanding an even lighter touch on regulation.

"Let us not forget that when we were being tough on regulation - not tough enough - we were opposed by many voices in the City and we were consistently opposed by the Conservative party at every stage, who said we were too heavy- handed in regulation, we were strangling financial companies, that we shouldn't have had the FSA at all. They opposed everything we did."

Government sources played down the significance of Balls's remarks. They said that he had simply answered questions in interviews about a speech he made on social work. They added that he had previously admitted that the government had not been tough enough on regulation, in a Channel 4 interview on Monday.

Osborne will attempt to intensify the pressure on Brown over the economy today when he says it is time to deliver "home truths" about the state of the economy. He will say in Birmingham: "We need to change from an economy built on debt to an economy powered by savings and real returns on effort. But we can only make it real if we are willing to confront some uncomfortable truths and tell people what they may not want to hear.

"It means telling people that they can't rely on massive increases in house prices to fund their retirement, and that they will have to save for a deposit to buy their own home. It means pointing out that increasing profits through ever higher debts is not a sustainable way to build a business."

Sleeping on it

A bed company has come up with a novel way of encouraging savers to - literally - stick their money under the mattress. Feather & Black has made a divan bed with a safe hidden in its base which it hopes will encourage people to "revert to the old-fashioned methods of saving". Managing director Robbie Feather says: "Confidence in banks has hit an all-time low and fears of a recession crime wave have been raised by the home secretary." However, the price of the bed will not appeal to penny pinchers - a double costs £949 and a single £769.Lisa Bachelor